There are several forces at work that have caused our present health care system to be costly and inefficient. What they are and what should be done to correct the situation are addressed here.

Debate over health care reform has focused largely on President Clinton's proposals and other Federal and state legislative initiatives. The dramatic changes occurring in the health care delivery system are driven not just by politics, however, but by fundamental economic forces acting on an industry that has long been structurally unstable. In a system plagued by market inefficiencies, a chronic imbalance of supply and demand, disturbing social inequities, and relentlessly rising costs, change is not only necessary, but inevitable.

The imbalances that destabilize the present health care system are deeply ingrained, the result of many complex and interrelated economic and social factors. Most Americans are covered by private insurance plans or by the government through Medicare, Medicaid, and other programs. Consumers of health care do not bear the cost of their care directly--for the most part they do not even pay the full cost of their insurance. Therefore, they have little incentive to limit their consumption or to look for less-expensive alternatives. Furthermore, because the science of medicine is complex, consumers remain relatively uninformed about health care and are heavily dependent on physicians and other providers to direct their health care purchases.

The present state of the health care industry is essentially the result of market failure. Because of the industry's unique financing system, the usual market forces that bring down costs and balance supply and demand fail to operate effectively.

Health care is in oversupply. Each day, over 35% of acute care hospital beds are empty. The nation's supply of physicians has increased by 50% since 1970, yet family doctors are in short supply, particularly in rural America. There are too many specialists and too few primary care doctors in many markets; approximately two-thirds of practicing physicians are specialists.

In spite of this oversupply, the costs of health care are rising relentlessly. Expenditures for health care in the U.S. now consume approximately 14% of the gross national product (GNP) and are projected to reach $1.7 trillion by the year 2000, consuming 19% of the GNP or nearly one-fifth of the nation's economic production. Although the rate of increase in medical costs slowed in 1991, it remained more than double the general inflation rate.

With costs rising this fast, one might suspect the providers of health care are reaping windfall profits. In fact, the opposite is true. Plagued by high overhead, uncompensated care, operating inefficiencies, and increasing equipment and labor costs, many hospitals and clinics are facing diminished profitability.

If rising costs have not translated into rising profitability, they also have not translated into reduced demand. The success of medical science has led to longer life spans, and as people live longer, they require more intensive anti expensive care. The high cost of sophisticated technology and treatments drives up the cost of health care--and at the same time the success of these treatments and technology drives up demands. The concurrent rise in the cost and demand for services is a rare phenomenon.

Perspectives on the American System

As costs increase, large purchasers of care--particularly government and corporations that provide insurance benefits for the majority of Americans--have become adamant in their demands that costs be reduced. They decry the inflation of health care costs and the overutilization of services. Health care costs of employers have risen from about two percent of payroll expense in 1960 to almost ten percent in many companies today. Similarly, steadily rising Medicare and Medicaid outlays create an annual budget dilemma in a Congress that must deal with a growing number of politically powerful beneficiaries who do not want their benefits cut or their share of program costs raised.

Meanwhile, the private practice health care system remains far too fragmented to administer efficiently. Patient care is difficult to coordinate and manage effectively when many physicians, hospitals, and other providers are solo operators who function autonomously.

Nonetheless, in response to pressures to improve its efficiency, the health care industry has begun to consolidate, moving toward organized systems or networks that provide a broad continuum of care. Programs to integrate hospitals and doctors into systems that are better able to manage the care of patients effectively are high on agendas in hospital board-rooms and in public forums.

Also, as part of overall efforts to contain costs, managed care programs have been growing rapidly. HMOs today cover more than 40 million Americans. Together with less-controlled forms of managed care (PPOs, point-of-service plans, etc.), these organizations enroll more than half of the employed population.

The Dilemma of the Uninsured

Such impressive managed care enrollments and reform efforts at all levels of American society attest to the social and political importance of health care. It is perhaps not surprising that Congress and most Presidents since World War II have attempted to enact various health care reform initiatives. Though not an established legal right in our country, health care is broadly perceived as a necessary service to which everyone should have access. An unwritten but solidly supported public policy is that everyone in the population should have health insurance protection.

Yet, despite the fact that over 80% of the American people have some health insurance, and despite Medicare and Medicaid--government insurance programs intended to protect the elderly and the poor--over 35 million citizens have no health insurance. Almost one-half of the uninsured are self-employed or work for firms with fewer than 25 employees, many of which cannot afford to pay for insurance benefits. Two-thirds of the uninsured are members of families in which at least one worker is employed full-time. Some of these uninsured workers may choose not to buy insurance, but many of them simply cannot afford it.

Most of those who lack insurance protection are at great personal disadvantage when they become ill and delay seeking treatment. Not only does this jeopardize their health, but it creates a financial burden on the rest of the nation. The uninsured tend to seek care in the costliest settings--hospital emergency rooms, where they are usually not turned away--and often when illness has become so acute it is much more expensive to treat.

The cost of covering the uninsured is borne by those who are insured or who can afford to pay. Even in the present health system, most of the uninsured now receive some needed care though public programs and uncompensated providers. But uncompensated care delivered by providers is not free, and the cost is shifted to those who can afford coverage. Thus, the cost of caring for the uninsured is already a large component of the nation's $900 billion-plus annual expenditure for health services.

Estimates of the cost of covering the uninsured vary widely--from $30 billion a year to over $90 billion. While the total cost of such coverage could well approach the higher number, the true incremental cost is likely to be closer to the lower estimate. Moreover, with coverage, the previously uninsured would receive more timely and more cost-effective care, resulting in better health and savings for the system.

The goal that everyone should be insured is, however, fraught with policy conflicts and often collides with a deeply held American belief that equity should be achieved with minimum government interference. This presents a familiar quandary: How to reduce inequities in health care with minimum government regulation. One of our biggest challenges in health system reform will be to ascertain that government intervenes only as necessary to achieve equity and to create incentives to restrain costs.

An Abundance of Answers

Solutions to the health care dilemma have arrived in almost paralyzing numbers. These range from "managed competition" to a single-payer approach. Many policy advocates--physicians, hospitals, insurers, legislators, and others--are searching for the right balance between allowing economic forces of the marketplace to prevail and adopting rules that will reduce inequities and costs at the same time. Most seek socially and politically correct incentives to encourage health care providers and consumers to make the wisest use of the nation's vast, yet increasingly costly, health resources.

One widely debated approach to health care cost containment would include a system of government price controls; another proposal would impose a government limit on total national health care expenditures-- private as well as public. Governmental price controls, such as were attempted during the Nixon Administration, have generally proven to be ineffective.

Fundamentally, price and supply controls do not address market imbalances; moreover, they stifle innovation and eventually lead to circumvention of the rules. Other industrialized nations have had negative experiences with state controls over prices and supply and today seek to implement economic incentives that will decrease reliance on government.

Some policy makers have advocated the rationing of care, and experiments are under way, as in Oregon, to provide financing only for specified types of medical conditions and treatments. We do not believe so radical a step is necessary or that it would be accepted by most Americans. It would be vulnerable to political changes and economic pressures. Rationing suggests the nation's problem is an insufficiency of resources, whereas the real problem is we are spending too much, our system is inefficient and needs fundamental restructuring.

Paradoxically, the theoretical solution of a totally open and competitive market-place--were it achievable--could not solve the problems plaguing the industry. Existing health insurance programs, deemed crucial from a social policy perspective, remove from the consumer much of the financial accountability essential to efficient use of services. Moreover, most consumers rely upon the providers of service, especially physicians, for their health care decisions and readily accept professional treatment recommendations regardless of their cost. Because of these practices, giving financial incentives to health care providers to encourage them to manage utilization and cost of services, even within the content of an insurance plan, is essential to the success of any effort to improve the system's efficiency.

While we are not advocates for a specific legislative alternative, we believe any program aimed at creating structural and long-term sustainable change should incorporate the following:

* Affordable coverage for the uninsured so that the care of this population can be effectively managed;

* A defined set of basic benefits for all Americans to promote comparability among health plan alternatives;

* Incentives to encourage enrollment in health plans that foster consumer and provider accountability for cost effective use of resources; and

* A competitive system that allows market forces to rationalize the system's supply imbalances without unnecessary regulatory intervention.

Improving the System

Managed care could be the most promising cornerstone of a program to improve the efficiency of our health care system. Through legislation or private initiative, incentives could be provided both for employers and consumers to shift from traditional insurance coverage to more efficient and competitive managed care plans.

If the nation moved to an all managed care HMO-type system, an estimated savings of 15 to 30% could be realized on typically covered benefits. National health care expenditures could be reduced by as much as $100 billion a year, assuming a 20% cost improvement for typically covered benefits--more than the incremental costs of covering basic health services for the uninsured.

HMOs, the most structured form of managed care, are gaining popularity because they are able to hold down costs for their members by providing only those services deemed medically appropriate and necessary. Unlike their fragmented fee-for-service counterparts, well-managed HMO providers are organized into delivery systems that have the capacity to coordinate care among doctors, hospitals, home health care, and other components of the system. In addition, by paying provider groups on a fixed monthly basis, many HMOs also provide economic incentives for doctors and hospitals to allocate health resources much more efficiently.

By contrast, the average total cost per employee (including out-of- pocket expenses) in a traditional indemnity health insurance program can be approximately 30% higher than in an HMO with comparable benefits. Impatient days per thousand people, for those under 65 years of age, average approximately 500 for indemnity insurance plans, compared to about 300 for HMOs.

* Managed care is emerging in many forms and is proving to be cost- effective. But it is not flawless. Some existing programs are simply discount fee-for-service plans which do little to reshape the delivery system or provide incentives to better manage the utilization of services. Information systems, essential to managed care, are in their infancy. More extensive data are needed to monitor levels and quality of service and to provide a means for purchasers and consumers to compare health plans. Clearly, the managed care concept needs to be further developed.

A Scenario for the Future

With numerous legislative and private initiatives being considered and implemented, it is difficult to predict with great certainly the precise course of the health care industry's evolution. However, the fundamental economic forces at play suggest the following developments are likely:

* A very large majority of Americans will be covered by managed care plans; consumers and providers alike will have economic incentives to control health care costs.

* In major markets, hospitals, physicians, and other providers will integrate to form delivery systems that will accept much of the financial risk of providing services to defined populations; in a competitive environment, these systems will compete with each other to provide care for customer groups.

* Health care insurers increasingly will focus their marketing and product development efforts in selected markets, as the need to manage market-specific delivery system relationships becomes more crucial to survival and success.

* Consolidations within the hospital industry, in response to competitive pressures, will continue as resource capacity is rationalized.

* The highly fragmented private practice environment will change dramatically; most physicians will practice in large groups or networks; the balance between primary care physicians and specialists will be improved.

* Quality indicators will be widely used to monitor performance of delivery systems and health plans and will become the means of providing accountability to the populations served.

* If competitive market forces are allowed to operate with only the minimal required intervention, the changes described above are almost certain to occur. The result will be a far more efficient health care system, able to provide quality care to most Americans and to offset the cost of covering the uninsured with savings accrued through increased efficiency. As a result, the excellent care now available to most Americans will be available to all at a cost our economy can bear.

Robert A. Go is in the Detroit office of Deloitte & Touche where he is Managing Director of the firm's Health Care Practice. This article is reprinted with permission of Deloitte & Touche from Perspectives on Business 1993.